2013 and Beyond: What’s In Store for U.S. Energy Markets?

Despite the good news that 2012 brought to much of the U.S. energy sector, the year was a challenging one for energy products traded on futures markets. Low volatility in some markets and regulatory uncertainty hurt volumes during the second half of the year across many of our products, including benchmarks such as NYMEX WTI.

But when looking at where we’ve been, where we are today, and what lies ahead, we see reason for optimism – on a macro level and for the energy markets.

Growing Crude Oil Production and Infrastructure

In 2011 and early 2012, we saw severe logistical constraints around our benchmark West Texas Intermediate contract. Increased domestic production that was piped to Cushing, Oklahoma, often stayed there because of few transportation options that could move it quickly to the Gulf and on to world markets. But with the reversal of the Seaway pipeline and continued expansion of rail, we’re seeing more WTI reach the Gulf Coast and Eastern refineries, which is a positive sign that WTI – still the most traded contract in the world with open interest near 1.6 million contracts – will narrow the existing spread with Brent, displace light sweet crude imports and stoke enthusiasm for the contract as the world’s benchmark.

Perhaps the best news for U.S. oil markets, and the economic impact that comes with their growth, is the increased appetite for investment from the energy industry and the expansion of market reach for North American crudes. The pipeline opportunities on the horizon are especially encouraging. Not only will the Seaway pipeline expand from 150,000 to 400,000 barrels per day piped to the Gulf, there is also the real possibility that TransCanada’s Keystone pipeline will be approved at some point now that the Presidential election has passed. In addition to pipelines, we continue to see more rail shipments. Most recently we saw Plains All American pipeline buy five rail loading terminals with a total capacity of 250,000 barrels per day, and three unloading terminals with total capacity of 335,000 barrels per day.

These are positive signs for domestic production and infrastructure. But they are also signs of a healthy future for WTI. According to a new report from the DOE’s EIA, by 2020 the U.S. could become the world’s largest oil producer – even surpassing Saudi Arabia – with production projected to reach 7.5 million barrels a day, an increase of more than 30 percent above 2011 numbers. As logistics and infrastructure improve, waterborne crudes like Brent and North African grades will be backed out of the North American market. When those imports are displaced, the relevance of WTI will increase and the correlations between WTI and other worldwide crudes will improve.

The Year of Natural Gas

As strong as the prospects are for oil, 2012 was the year of natural gas, and that phenomenon shows no signs of slowing down. The recent burst in production due to technology improvements in fracking and horizontal drilling has sent prices to low levels and has encouraged more in the industry and Washington to look at the tremendous benefits that exporting natural gas would have on North American markets.

Last year, about 94 percent of the gas consumed in the United States was produced domestically, up 11 percent from 2007 levels. Fracking has become so successful that over the next 25 years, the Energy Information Administration projects it will account for about half of the natural gas production in the U.S. The EIA projects 13.6 trillion cubic feet of natural gas coming from domestic shale by 2035, up from the current 5 trillion cubic feet produced today.

With $3 natural gas in the U.S. and world markets pricing it between $11-13/MMBTU, the conditions are right for a market in exports. Cheniere Energy’s Liquefied Natural Gas (LNG) Terminal – approved by the energy department earlier this year – could begin exporting LNG as soon as 2015. This project, and others like it in the future, could mark the beginning of the development of a global market for BTUs, a profound change from where we are today.

Fracking and exports are not events that will only influence price and market activity in the short term. They are an economic shift in the global energy system that moves us towards the goal of self-sufficiency and shapes how and what markets react to, and that is reason for optimism.

Regulatory Uncertainty

Regulation will continue to alter the landscape as well. We have spent considerable effort over the last year working with our customers and regulators to offer more choice in how market participants execute and clear OTC trades. Participants need flexibility and choice as economic, technological and regulatory factors bring new risks into play.

In response to Dodd-Frank regulations, all actively traded futures contracts on CME ClearPort have been listed for execution:

on the CME Globex central limit order book,

as cross trades,

on the Trading Floor, and

as block trades.

The market has responded to this change by migrating the majority of trading from swaps to futures. Since October 15, our customers have consistently traded approximately 80 percent as futures, compared to approximately 15 percent beforehand.

As regulations continue to evolve, we will work with our customers, regulators and other market participants to offer the flexibility and choice of execution that customers need as they access liquidity and manage risk in the global energy marketplace.

However, with these changes, we’re seeing changes to the way market participants trade – both from a technology and regulatory standpoint. In response, we launched a new front end trading, online application for the energy markets earlier this year called CME Direct. We’ve seen great adoption of this already and are seeing strong early activity in our nat gas, power, emissions and oil markets.

In 2012, we witnessed impactful, and often unexpected, changes to the regulatory landscape and to the fundamentals of the energy markets. But it’s in these most challenging of times that we often see the best opportunities for innovation and opportunity emerge. We’re seeing that across the energy sector with new technology and production, and in the tremendous build-out of infrastructure that is bringing critical resources to the markets where they are needed most. And this will continue to play itself out in our energy markets, where these big changes are reflected in the ongoing search for risk management, price discovery and liquidity.

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About OpenMarkets

OPENMARKETS online magazine, produced by CME Group, is designed to keep you up-to-date on developments that can enhance your successful participation in the dynamic derivatives industry. The magazine features customer case histories, new product information, technology updates, trend stories, and timely online-only news briefs.

About CME Group

About CME Group

As the world’s leading and most diverse derivatives marketplace, CME Group is where the world comes to manage risk. CME Group exchanges offer the widest range of global benchmark products across all major asset classes, including futures and options based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather and real estate. CME Group brings buyers and sellers together through the CME Globex electronic trading platform and trading facilities in New York and Chicago. CME Group also operates CME Clearing, one of the largest central counterparty clearing services in the world, which provides clearing and settlement services for exchange-traded contracts, as well as for over-the-counter derivatives transactions through CME ClearPort.